TAX TIP - NONQUALIFIED STOCK OPTIONS (NSOs)

  1. Is there a tax on the exercise of a nonqualified stock option (NSO)? – There is no tax when the employer grants options to an employee. There is a tax when the employee exercises a NSO. The employee has compensation income for the difference between the fair market value of the stock on the exercise date over the exercise price. (For example, an employee exercises 100 options with an exercise price of $10 per share when the value of the stock is $30 per share. The employee has compensation income of $20 per share times 100 shares).
  1. Is there income tax withholding on the exercise of a NSO? – Since the employee has income on the exercise of a NSO, the employer must report the income on the employee’s W-2 form. Therefore, the employer must withhold 28% federal income tax, 6.2% social security tax (on up to $76,200 of compensation combined with employee’s regular salary), 1.45% Medicare tax, and 5.95% Massachusetts state income tax.
  1. What value of NSOs do you need to exercise if you want $20,000 cash? – Remember that the exercise of a NSO is taxed as compensation and taxes will be withheld. You would do a simultaneous exercise and sale of options. So, if you are under the social security maximum wage limit of $76,200, you would need to exercise NSOs equal to $34,247 to have $20,000 cash left after tax withholding.
  1. How much cash is needed to exercise $20,000 worth of options and not sell the stock? – You would need $28,320 of cash to exercise $20,000 worth of options and hold on to the stock. That is made up of the $20,000 to exercise the stock, 28% federal tax, 6.2% social security tax, 1.45% Medicare tax and 5.95% Massachusetts tax.
  1. What is the tax basis of stock acquired by the exercise of a NSO? – The tax basis of stock acquired by the exercise of a NSO is equal to the fair market value of the stock on the date of exercise. That is equal to the exercise price paid plus the income reported on the W-2 form as a result of the exercise.
  1. What if the stock is sold some time after the original exercise of the NSO? – If the stock is sold after it was held for at least one year after the exercise it is a long-term capital gain. The maximum tax on long-term capital gains is 20%. If the stock is sold after it was held for less than one year it is a short-term capital gain. Short-term gains are taxed at ordinary income tax rates ranging from 15% to 39.6%.

See next month for a discussion of incentive stock options.

We have experience guiding clients through the maze of stock option decisions. For more information contact Nick Puniello @ .